Jane Bryant Quinn — Muni Bond Buying Opportunity
Kurt Brouwer May 14th, 2008
Muni Bonds Make Sense Without The Insurance (Bloomberg, May 8, 2008, Jane Bryant Quinn)
…In fact, muni yields are practically irresistible today, for taxable accounts. The wasteful part is the insurance. You don’t need it and never did. The bonds themselves are better, safer credits than the expensive insurance wrapped around them.
Municipal bond insurance provides investors with a guarantee. If the issuer defaults, the insurer will cover the interest and principal payments as they come due. This form of comfort comes at a price. Bonds from sound insurers yield about 0.2 percent to 0.3 percent less than similar bonds that are uninsured, says Jerry Webman, chief economist for OppenheimerFunds in New York.
The cost isn’t worth it. Muni bonds hardly ever default. A recent study by Standard & Poor’s of uninsured munis, issued by 10,268 borrowing entities since 1986, found zero defaults among those rated AAA and AA at any point during their life. Among the single A’s, 0.16 percent defaulted and among the BBB’s, only 0.29 percent. That’s a far better record than you see in quality corporate bonds.
Muni bond insurance entered the tax-exempt market to help municipalities improve their credit ratings. The insurers were all rated AAA. Cities and states with lower ratings could raise themselves to AAA by buying the insurers’ guarantee. That reduced the interest rate they had to pay. Roughly half of all municipal issues are insured.
Sound Safer
To retail investors, AAA insured bonds sound safer than uninsured AA’s — even though AA munis are historically safe.
…Starting this month, Moody’s will give two ratings to municipals, if they ask for it: the lower, muni rating and the higher “global” rating they would get if they were judged by the kinder standards used for corporate bonds. As an example, a muni backed by the taxing power of the government and normally rated A3 (Moody’s seventh from the top) could rise to Aa1 (its second-highest rating), using the corporate-equivalent, or “global” scale.
…Occasionally, municipalities do default. Jefferson County, Alabama, home to Birmingham, got flim-flammed by Wall Street’s white-shoe types, invested heavily in exotic securities and now can’t pay the interest due. It’s talking bankruptcy but rescue negotiations are under way. Its bonds are insured primarily by two companies, Financial Guaranty Insurance Co. and XL Capital Assurance. They both have been downgraded substantially by all three rating companies.
The credit-market failures, plus the troubles of muni-bond insurers, have driven the price of munis down and the yields up. They have become a huge buying opportunity for investors in tax exempts. Ten-year AAA-rated bonds are now yielding an average of 3.86 percent — that’s a tad more than comparable, taxable Treasury bonds.
For investors, however, buying individual bonds carries extra risk, even if they’re insured. If you need cash and have to sell the bonds before maturity, you’ll take a big haircut on the retail price.
Mutual funds are a better choice. You get decent diversification and your manager buys and sells the bonds at the institutional, wholesale price. Look for low annual costs, meaning less than 0.5 percent. Some munis get caught by the alternative minimum tax, so if you’re in that bracket choose a fund that’s AMT-free. As for mutual funds that buy only bonds that are insured? Don’t bother...
Our good friend, Jane Bryant Quinn, is one of the best and most prolific personal finance columnists (see Online Banking Pays Off). I agree with her that muni bonds funds make sense for many taxable investors (see Tax-Free Muni Bond Yields Now Above Taxable Treasury Yields). Yields on Treasury bonds are moving up quickly now though, so Treasury yields may no longer be higher than those on comparable maturity muni bonds.
Assuming income tax rates go up (see Largest Tax Increase Since World War II), tax-exempt muni bond funds will make even more sense for income investors in medium to high tax brackets.
The issue of municipal bond insurance was a joke because muni bonds almost never default. That’s what made it such a great business for MBIA and Ambac. They did very well insuring muni bonds and it was only when they ventured into insurance for other types of bonds that they got in trouble (see Hedge Fund Losses Roil Muni Bond Market).
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